International evidence of temporary and permanent stock-price innovations: a multivariate approach

Abstract

The existence, size, and dynamic effect of temporary and permanent stock-price innovations has been a prominent issue in financial economics. Previous univariate and multivariate studies find that temporary innovations exist, but they do not yield a consensus regarding the size and dynamic effect of the temporary and permanent stock-price innovations. Real interest rates are intrinsically related to real stock prices through standard present-value models. This note applies Blanchard and Quah's (American Economic Review, 79, 665-673, 1989) bivariate, structural VAR model to monthly real stock returns and real interest rates from six major international financial markets including the US. Using 12 monthly VAR lags in order to capture annual variation in stock prices, this model finds a dramatic range in the size and dynamic effect of temporary and permanent stock-price innovations across the six international financial markets.